With Greece fast running out of cash, investors and policy makers have begun contemplating the possibility of a default and its consequences.
The question they are asking is whether it is possible to keep Athens in the eurozone even if it failed to repay some of its creditors, thereby sparing the global economy renewed uncertainty.
“Our base-case scenario remains that Greece and its international partners will reach an agreement,” wrote Reinhard Cluse, an economist at UBS, in a research note. “Nevertheless . . . the risk of failure and eventual Grexit [Greek exit from the currency bloc] should not be underestimated”.
The cash position of the Greek government is extremely murky, making it hard to assess when exactly Athens might be forced to renege on its obligations.
Silvia Merler, an economist at European think-tank Bruegel, has calculated that the government is running a better than expected primary surplus. However, this is largely the result of a severe squeeze on public spending, which is partly due to delayed supplier payments.
Athens faces a challenging debt redemption schedule during the summer with about €2bn due to the International Monetary Fund and €6.5bn to the European Central Bank and other eurozone central banks between June and August.
The Greek government also has to pay its civil servants and pensioners, while the existing, stalled bailout programme with the eurozone terminates at the end of June.
Athens is adamant that an agreement is in sight but the possibility of an accident remains. While a default need not necessarily lead to a Grexit economists warn that it would substantially increase the risks of a departure.
“Default but no Grexit cannot be a stable equilibrium,” Mr Cluse said.
The short-term consequences of a default may depend on who exactly the Greek government fails to pay, as well as on the reaction by creditors — in particular depositors and the ECB. A default by Athens on domestic payment obligations, in the form of IOUs to pensioners and civil servants, would probably be the least risky. While such a move would almost certainly be challenged in court — as well as creating substantial political problems for the government — any ruling would be delayed.
A default on IMF loans would look politically ugly, as Greece would indirectly be refusing to repay some of the poorest countries in the world who contribute to the institution’s coffers. However, it is generally seen as less risky than a default to the ECB. The fund’s executive board would only be notified a month after Greece had not met its obligations and it would take several months before any concrete steps, which could go as far as excluding Greece from the IMF, were taken.
Refusing to pay the IMF would be unlikely to trigger an automatic cross-default on other obligations. For example, the European Financial Stability Facility, the eurozone rescue fund, would need to decide if Greece was in default, leaving room for discretion among other European governments.
“Defaulting on the IMF would have serious consequences but may well be possible,” Ms Merler said.
A default to the ECB is generally seen as the most treacherous option. The Greek banking system relies on emergency funding from the central bank and any decision to close the liquidity taps would result in lenders being unable to meet their obligations.
“The main thing which counts is what will the ECB do with ELA [emergency liquidity assistance],” said Yannis Manuelides, a partner at law firm Allen & Overy. “The governing council will need to read the tea leaves and take a decision”.
The rules governing the provision of ELA are opaque but require the central bank to assess that recipient lenders are solvent.
Since Greek banks hold sizeable amounts of government bonds — which are routinely pledged to the ECB as collateral — defaulting on them would make it hard for policy makers in Frankfurt to conclude that Greek lenders could stand on their own feet.
There could, in theory, be other options. These include a bail-in of bondholders and depositors to strengthen the capital buffer of Greek banks; or a eurozone-wide guarantee on the Greek banking system. However, these would be either difficult to enact domestically or rely on the goodwill of international partners, who stand to shoulder the brunt of a default.
Were the ECB to pull the plug on ELA, the government would be left with no option but to impose capital controls and print “new drachmas” to stem an inevitable bank run.
While exit from the monetary union is illegal under EU law, it would nevertheless become a reality.
Source: http://www.ft.com/cms/s/0/9f7c7b04-fede-11e4-84b2-00144feabdc0.html?siteedition=uk#axzz3ajZXOgkD